The long road

The world economy has entered recession. Recent economic data indicate it will be deep. But the length of the recession, and the eventual recovery, remain uncertain. We have continued to rely on scenario analysis to inform our views. A V-Shaped economic recovery remains unlikely. We also think a depression scenario remains unlikely. Instead we expect ultra-low interest rates to support a long, gradual recovery over the next decade.

Lockdowns have forced unemployment.

Job losses globally have been devastatingly high. The unemployment rate has surged in the US and in Australia (chart 1).

Chart 1: The unemployment rate surged as economic lockdowns persisted.

Job losses have continued in the US but peaked on a weekly basis in late March (chart 2). We expect it will take years to get jobs back to pre-Covid19 levels. But we think there could be a spike in job gains in the Q4 2020 as the economy begins to reopen.

Chart 2: Initial jobless claims have peaked in March 2020.

Confidence takes a hit.

Job losses, wealth destruction and uncertainty has crushed consumer confidence (Chart 3). The decline in confidence is comparable to that during the global recession in 2008. Weak confidence and wage uncertainty have resulted in consumer spending plummeting. But unlike previous recessions, this one has been forced on households by policymakers. There is likely to be some pent-up demand coming out of the economic lockdowns. We see signs that confidence and spending could begin to recover slowly through H2 2020.

Chart 3: Confidence has slumped as shutdowns were implemented.

Credit risk remains elevated.

Heading into 2020, worsening credit quality and rising leverage were our key economic concerns. During March, credit spreads widened significantly. Spreads remain wide, particularly in parts of the high yield universe. But the Fed’s commitment to provide liquidity has helped spreads narrow (Chart 4). We remain worried about lower quality corporate credit. But we think that investment grade credit spreads are likely to be protected by ultra-accommodative Fed policy over the next decade.

Chart 4: Credit spreads have narrowed but remain wide relative to history.

Policy support is critical.

The economic outlook remains contingent on policy action. Global central banks and governments have been swift and aggressive in their support. The Fed has expanded its balance sheet by an equivalent of 10% of GDP (chart 5).

Chart 5: The Fed’s balance sheet expansion has been swift and aggressive.

Global governments have provided significant fiscal support (chart 6). We expect more fiscal support when economies are reopened.

Chart 6: Government fiscal support – already a lot, but more is to come.

We also expect central banks will keep policy accommodative for years to come – we think it could be close to ten years before the Fed hikes rates, similar to the period post-2008.

Markets have responded, but unevenly.

Risk assets have recovered off their March lows. But the recovery has been uneven (chart 7). There has been near-term volatility. This is true globally.

Chart 7: US equity market sectors have recovered unevenly.

We think equity market recoveries will be gradual and protracted. Some countries’ equity markets are at risk of structural economic weakness. The outlook remains uncertain, but we think it looks better than it did in late-2019.

Looking to the future.

We ended 2019 expecting a recession in 2020. It is happening now. We expect the recession to last two or three quarters, before a gradual recovery takes place. We think asset markets are for the most part looking forward to that gradual recovery. In our 2020 Medium-Term Outlook we wrote about the importance of building resilient portfolios. If you would like to find out more about how we can help build resilience, reach out to our Portfolio Advisory Service to find out how we can assist with managing your investment challenges in this period of uncertainty.


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